SOME 18 MONTHS AFTER amendments by the Canadian Securities Administrators to the takeover-bid rules, which came into effect in May 2016, predictions that the changes would alter processes and strategies in the hostile M&A market appear to have been borne out — at least in part.

The key changes mandated a 105-day minimum deposit period, a 50-per-cent minimum tender requirement, and a compulsory 10-day extension of bids where a bidder had received tenders of more than 50 per cent of outstanding securities.

The extended 105-day minimum deposit period, a significant uptick from the original 35 days, has given targets 70 additional days to find a white knight bidder. This has reduced the relevance and efficacy of shareholder rights plans (also known as “poison pills”), the traditional defence of choice in response to unsolicited bids. The new “just say slow” minimum bid period also gives other interested bidders a longer period to intervene, creating uncertainty for initial bidders, especially hostile ones — an uncertainty that could give boards more negotiating leverage. “Poison pills are redundant now, because they amount to a tactic used to buy time, something the regulators have now provided,” says John Emanoilidis, a partner in the Toronto office of Torys LLP.

While the new regime contemplates exceptions to the 105-day regime, M&A lawyers predicted that they would be hard to come by, granted only when the expiry of the new bid period approached and then only in extraordinary circumstances. “If someone tried to issue a poison pill on day 104, it might buy them a few days but it would soon be struck down,” says Chris Sunstrum of Goodmans LLP in Toronto.

For all intents and purposes, then, the poison pill defence to unsolicited bids now teeters on irrelevance. Indeed, not a single poison pill dispute has featured in any hostile-bid proceeding since the adoption of the new regime. “With the exception, perhaps, of using them to prevent creeping takeovers [where a party loath to make a hostile bid seeks to accumulate a position by buying shares in the market over a period of time], poison pills are no longer an effective strategy,” says David Woollcombe of McCarthy Tétrault LLP in Toronto.

THE M&A COMMUNITY has generally regarded the regime changes as favouring targets. “Time is a target’s best weapon, and the extension of the minimum bid period gives them just that without having to resort to anything else,” Woolcombe says. Besides, it’s not as if other defensive tactics are not available. “Everyone predicted that defensive tactics other than poison pills would become common under the new regime,” Emanoilidis says.

The flavour of the day appears to be the tactical private placement, a strategy that is hardly new to Canada but eventually lost favour as poison pills gained popularity. For a number of reasons, however, tactical private placements have re-emerged under the new bid regime. “Among other things, the 105-day minimum deposit period provides significantly more time to execute a private placement before a bid’s expiry,” says Chris Sunstrum, a partner in the Toronto office of Goodmans LLP.

“As well, the inability of bidders to waive the 50-per-cent minimum tender condition may enhance the tactical effectiveness of private placements that withstand regulatory scrutiny,” he says. “And, finally, the extended timeline and increased uncertainty in the outcome of a bid may make boards more reluctant to risk deferring or forgoing currently available opportunities — which may involve private placements — that they believe are in the corporation’s best interests.”

Tactical private placements can achieve a number of purposes. Here the mandatory majority tender requirement comes into play. “What this threshold has done is to put the decision in the hands of the shareholders collectively because no one shareholder can tender to the bid unless 50 per cent do,” says Patricia Olasker in Davies Ward Phillips & Vineberg LLP’s Toronto office. “That makes private placements very attractive as a way of preventing the bidder from reaching the threshold 50 per cent.”

Private placements can also stand in the way of a bidder’s goal of privatizing a public company. “Even if the bidder gets to 50 per cent, an acquirer needs 66.67 per cent to be assured of taking a company private,” says Jeremy Fraiberg in Osler, Hoskin & Harcourt LLP’s Toronto office. They can also increase bidders’ costs by forcing them to buy the newly issued stock at what is likely a premium to the market price. And, finally, the increased financing could lure in a superior proposal to the existing bid.

But private placements have their limitations: investor demand for the placement simply may not exist, and even if it does, the placement may not advance a target’s goals. Moreover, private placements are practical only in the case of small-cap issuers, or where a small number of shares are required to achieve a target’s objectives. “For a large cap, a private placement isn’t likely to amount to more than a rounding error in calculating the share capital,” Woollcombe says.

There is, however, another, bigger problem with private placements. They are subject to scrutiny under securities regulators’ “public interest” jurisdiction. Whether any such placement will pass muster is a difficult question. “Private placements, unlike rights plans, can serve purposes — such as the legitimate need for financing — beyond simply blocking a bid that may benefit the target and its shareholders,” Sunstrum says. “So, for this and other reasons, securities regulators have expressed the need for caution when intervening in private placements on public interest grounds.”

Then there’s the uncertainty created by the fact that the various provincial securities regulators have been somewhat less than consistent in their approaches to defensive tactics and the parameters of their respective public interest jurisdictions. For example, the BC Securities Commission decision in Re Red Eagle, 2015 BCSECCOM 401, and the Alberta Securities Commission’s ruling in Re ARC Equity Management, 2009 ABASC 390, which allowed private placements to proceed in the context of contested bids, stand in contrast to the 2012 rulings in AbitibiBowater v. Fibrek from in Québec, 2012 QCBDR 95, and Re Inmet Mining Corp. from BC, 2012 BCSECCOM 409, where the private placements were cease-traded.

Fortunately, in Re Hecla Mining Co. (2016 ONSEC 32)and Re Dolly Varden Silver Corp. (2016 BCSECCOM 268), the first decisions under the new regime, the Ontario Securities Commission (OSC) and the British Columbia Securities Commission (BCSC) went some way to establishing greater certainty about how regulators would approach private placements.

Because the new regime did not address defensive measures other than poison pills, the relatively small transaction, involving some $12 million, drew national attention. It raised squarely the question of whether private placements could serve a more prominent tactical purpose as a defensive tactic under the new regime than it had under the old one. “Dolly Varden has resolved some of the confusion that had developed in the jurisprudence,” Olasker says. “The decision knits all the principles together in a way that makes them coherent and sets out a protocol for approaching the issue.”

Hecla Mining’s hostile takeover bid for Dolly Varden in early July 2016 was the first contested transaction since the new regime came into force. But about a week after Hecla made its intentions public, and three days before the takeover bid was launched, Dolly Varden announced that it would be seeking a private placement that could, as a side effect, discourage the takeover. Hecla sought cease-trade orders from both the Ontario Securities Commission (OSC) and the British Columbia Securities Commission (BCSC).

Following a joint hearing, the OSC and the BCSC both dismissed the cease-trade applications. In reasons released in October 2016, they ruled that Dolly Varden’s need for financing was genuine and immediate and that the private placement was not a defensive tactic by any measure. In so concluding, the panels placed considerable emphasis on the fact that Dolly Varden had been considering an equity financing before Hecla’s bid emerged.

“So if a company is in the process of raising money, and especially if it has a process in place, it will likely not be derailed just because a hostile bidder has emerged,” Fraiberg says. “On the other hand, if no process is in place, regulators will look at the placement more skeptically.”

THE REGULATORS ALSO RULED that determining the validity of a private placement involved a balance between the shareholders’ right to determine whether to accept the bid and a board’s business judgment. This balance, in turn, required a consideration of a number of factors including: an inquiry into whether the private placement provided other benefits to the target’s shareholder, such as funding for operations during the bid period; the impact of the placement on shareholders’ right to tender; the participation of related or similar parties in taking up the placement; the target shareholders’ views about the bid and the placement; and whether the board adequately balanced the private placement’s benefits and its impact on the bid.

If nothing else, the decisions established the efficacy of private placements as tactical tools in the context of hostile bids: Hecla withdrew its bid almost immediately after the Commissions released their orders.

At the same time, the decisions circumscribe the availability of the strategy. “Dolly Varden makes it clear that regulators will not allow private placements to stand in the face of the core principle that shareholders should be allowed to choose,” Woollcombe says. “That leaves boards with very little in the way of defensive tactics, but that’s what the regulators are looking for: having levelled the field by giving boards significantly more time to find alternatives than they had before, they want to protect shareholders’ primacy.”

So while M&A lawyers have welcomed the analytical framework that Dolly Varden establishes, many believe that regulators’ substantive position on private placements remains true to its historical roots. “Nothing’s changed, in the sense that good-faith private placements will be supported and allowed no matter when they are effected,” says Walied Soliman in Norton Rose Fulbright Canada LLP’s Toronto office. “But when indications exist that the private placement or other financing is designed primarily to hinder the corporate democratic process, regulators will at the least take a closer look at the situation.”

What seems clear is that private placements will not approach the ubiquity that poison pills had as a defensive tactic. Instead, their role will likely be more focused. “Firstly, if there’s a financing need — even one that is not immediate, but is in fact in the best interests of shareholders — a private placement could well get regulatory approval,” Sunstrum says. “Secondly, if a great financing transaction comes along, and it’s not yet clear what’s going to happen with the bid, doing the transaction could be regarded as acting in good faith even if the transaction could have a tactical impact on the bid.”

AS IT TURNS OUT,Dolly Varden’s impact may not be limited to M&A takeover situations. The OSC’s June 2017 reasons in Re Eco Oro Minerals (2017 ONSEC 23) suggest that private placements made during proxy contests will also be closely scrutinized. “Eco Oro recognizes the reality that some changes in control are effected by way of bids and some by way of proxy contests,” Woollcombe says.

At the heart of Eco Oro is the deal that cash-strapped Eco made with Trexs Investments, LLC in the summer of 2016. The company had only $31,000 in the bank at the time, and its only real asset was an arbitration claim against the Colombian government. In return for a US$15-million investment that allowed Eco to fund the arbitration, the company issued contingent value rights and convertible notes to Trexs and certain participating shareholders and insiders that entitled them to 78 per cent of the gross proceeds from the arbitration.

In February 2017, the dissident shareholders requisitioned a special meeting for the purpose of replacing the existing directors and electing a new board. That meeting was set for April 25.

In March, Eco, after obtaining conditional approval from the Toronto Stock Exchange, converted a portion of the notes by issuing 10.6 million common shares to the investors. This served to reduce the company’s debt, but increased investors’ control of the company from approximately 41 per cent to 46 per cent.

The dissidents asked the OSC to overturn the TSX’s approval of the transaction. In April, the OSC agreed and ordered a shareholder vote. But whereas the OSC and BCSC decided Dolly Varden based on their public interest jurisdiction, the Eco Oro ruling is based on TSX rules and not on the OSC’s public interest jurisdiction.

While many observers have characterized the key issues as being the extent to which the OSC will tolerate private placements during proxy contests, its precise impact is clouded by the fact that the determinative factor in the OSC refusal to approve the placement was Eco’s failure to make full disclosure to the TSX when it sought that approval.

The issue arose because, when Eco completed the requisite TSX form, it answered “no” to the question, “Could the placement materially affect control of the company?” That question, according to the TSX Company Manual, included anything that could influence the outcome of a vote. The OSC concluded that Eco had been “less than forthcoming” in its disclosure. This meant that the TSX did not have all the material information before it, a fact that was central to the OSC’s decision to overturn the placement.

But even in this context, Eco leaves important questions unanswered. The ruling provides no guidance as to the standard of proof the TSX must require to conclude that a transaction materially affects control of a company, or as to who will bear the burden of proof.

And because the OSC specifically declined to discuss whether it viewed the placement as contrary to the public interest, key questions also remain as to how the commission will approach these placements. “The decision leaves open whether tactical private placements during a proxy contest can be challenged under the OSC’s public interest jurisdiction if they otherwise comply with the TSX’s rules, and if so, whether the analytical framework would be the same as Dolly Varden or whether different considerations would apply,” Sunstrum says. “Still, my reading of Eco is that the OSC is saying that they will scrutinize private placements in proxy contexts as carefully as they do in bids.”

However that may be, Sunstrum believes that there may be more room for private placements in proxy situations than in takeover situations. “In a broad sense, Eco recognizes the principle that it is at least as important to protect a shareholder’s right to vote as it is to protect the right to tender to a bid, so there’s no clear reason why the treatment of private placements in either case should differ fundamentally from each other,” Sunstrum says. “On the other hand, Eco doesn’t do the same kind of balancing that we saw in Dolly Varden, and it remains to be seen precisely how the OSC will deal with the public interest question in the proxy context.”

What seems apparent, however, is that, if private placements are more likely to survive scrutiny in the proxy context, proxy fights could become a more common way of seeking control, especially “negative control” (where a shareholder maintains voting control without equity ownership). So far, that hasn’t happened, likely because regulators haven’t clarified their approach. “I suspect that Eco is just chapter one in the proxy story,” Sunstrum says.

Meanwhile, a widespread belief that the new regime would deter hostile bids hasn’t panned out. According to a study by Laurel Hill, a proxy solicitation firm, the seven hostile bids that occurred in the year following the regime’s inception mean that activity was “effectively unchanged” from recent years.

Whether the environment will remain stable remains to be seen. But it may be seen soon: Eco has appealed the OSC’s decision to the Ontario Divisional Court.